Israeli VC: tech exit valuations rising

"Silicon Wadi", Israel's booming high-tech venture capital market, is considered by some to be second only to Silicon Valley. The internet, software and communications sectors have grown in recent years, and cyber-security measures like fraud detection and online identity software is where the country seems to have a real advantage at the moment. According to the Tel Aviv-based Israel Venture Capital Research Centre (IVC), there are 224 cyber-security companies in Israel, 114 of which launched after 2010. Israeli technology is also emerging within the cloud infrastructure, software-as-a-service and mobile payments segments.

Israel, which boasts the highest R&D expenditure as a percentage of GDP worldwide, has an advantage in training emerging entrepreneurs through the mandatory military service, where Israelis are exposed early to and trained in using highly complex technologies. While many young companies develop through strong bonds between military friends and entrepreneurs, significant and scalable Israeli companies are just now starting to emerge in the global marketplace.

"Israeli companies usually sell before they become really big. But Israel's ecosystem is increasingly supporting and starting to see local start-ups through their growth into large multi-billion companies," says Michael Eisenberg, partner at the $140m venture fund Aleph. "We've started seeing a momentum with scalable companies – like Wix, Waze and Conduit – but these have historically been the exception. We're focused on changing that."

And there is reason to be optimistic. Tel Aviv-based IVC produced a report in late December showing the value of VC exits in 2013 – either via M&A deals or IPOs –  was the highest in 10 years at slightly more than €3bn. At the same time, the proportion of smaller deals of less than €7m has decreased dramatically. Moreover, 2013's average deal value of €87m is more than double the €40m mean witnessed over the past decade. Overall the report paints the picture of a maturing industry.

According to Shardul Shah of Index Ventures, there are two underlying factors feeding this optimism: "Success begets success – the volume and activity of value-added angels is growing, and as more teams experience success, best practices proliferate."

Large exits on the rise
Large exits seen in the Israeli market last year included BlueRun Ventures' sale of map software producer Waze to Google for €704m in June and Cisco System's acquisition of software maker Intucell from Bessemer Venture Partners for €346m. In November, Bessemer-backed website builder Wix raised $127m in the largest-ever IPO for an Israeli firm.

According to IVC, VC firms accounted for 63% of the 80 deals involving Israeli and Israel-related high-tech companies in 2013 with a total deal value of close to €5bn. Israeli-run Viber recently joined Waze, Intucell, Wix, Trusteer, PrimeSense and several others in the spate of exits above the $400m mark completed over the past two years. Following Viber's $900m sale to Rakuten, the ongoing debate of whether or not Israel can produce big exits might finally be put to rest.

Last year's record high in exit valuations begs the question: is it time for European VCs to take a serious look at Israeli technology investments? Adam Fisher, partner at Bessemer, believes so: "At the moment there are only a handful of European VCs with a mandate that allows them to invest here, like Index and Accel – others are too small. But, it should attract more Europe-based VC firms. There is no question we're seeing positive developments."

Israeli firms typically invest up to $10m per transaction and most venture funds have less than $200m in capital. According to Fisher, where US and Asian funds – as well as their European counterparts – have a real advantage is in the later rounds of $15-30m. Israel could present challenges such as a distant location, cultural differences and a high density of US firms on the ground, but one possibility for gaining a foothold could be partnering with local players to minimise risk in the beginning, just like US firms did in their early forays into Silicon Wadi in the 1990's.

Fisher points to another issue with the Europe/Israel cross-cultural venture relationship: one of value-building in the local market. "Even when European VCs invest [in Israel], the US is still the key target market. The interesting question here is: what, apart from capital, can they bring to Israeli companies?"

According to Shah, Europe and Israel could mutually benefit from cooperating on issues such as talent exchange and around information security. "US and European investors can introduce customers, mentors, provide support for entering new geographies and facilitate access to media," says Shah. Commenting on the challenges of investing in Israel he says: "There are no shortcuts. It requires persistence, effort, energy, and thoughtfulness to build a network. The appetite for investing in Israel will certainly increase, but execution is difficult."

The high valuations have raised concerns about another tech bubble approaching in the wake of the Viber deal, with some arguing that recent multi-million tech company valuations are based on the value of other similar companies, rather than revenues or profits. But Fisher doesn't view this as a problem: "There is nothing that is reminiscent of 2009 today; that was a very different time. Companies are creating tremendous value at a faster pace than ever seen before and I don't think the recent valuation increases mark the start of a new tech bubble."

Bubble or not, there is no doubt that the mega-exits have already attracted the attention of European VCs. It remains to be seen whether these can mimic the success of Index and Accel in the years to come.

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